Good for workers, good for businesses

When President Trump addressed the Congress in February, he promised “massive tax relief for the middle class.” Unfortunately, both the President’s one-page tax plan and the plan put forward by House Speaker Paul Ryan are tilted heavily toward cuts for the highest-income individuals. It will be up to congressional Democrats to hold the President to his promise.

Criticizing the Republican proposals won’t be enough. As White House veteran Ron Klain recently observed, “tax reform is one area where the opposition cannot beat something with nothing. Democrats need to have an alternative proposal to put up against the GOP plan.”

If the goal is to help middle class workers, the surest way is by reducing the payroll tax. Income taxes get all the attention, but more than three-fifths of U.S. households pay more in payroll tax — which comes out of your paycheck to fund Social Security and Medicare — than in income tax. So-called “Trump voters,” the voters who feel left behind by global competition, are certainly among this group.

Reducing payroll taxes would put real money in these workers’ pockets immediately. That’s why President Obama and Congress, in the depths of the Great Recession, enacted a temporary cut in payroll taxes. Unfortunately, that cut sunsets in 2013, because Congress couldn’t identify a revenue source to pay for it.

There is a way to pay for a permanent cut: eliminate a loophole built into the payroll tax itself — one of the biggest loopholes, in fact, in the entire tax code.

The payroll tax operates unlike any other tax. The tax rate actually goes down for high-income people. Workers pay 7.65% of the first $127,000 they earn in a year. Any income above $127,000 is taxed at only 1.45%. (The employer also pays a tax equal to what the employee pays — more on that in a moment.)

Worse, the payroll tax doesn’t apply to income from dividends, interest or stock trading — and that income goes overwhelmingly to the wealthiest families. In short, the payroll tax is deeply regressive.

If Congress eliminated the loophole, and applied the payroll tax equally to all income, it could reduce the tax rate for low- and middle-income families from 7.65% to 6.2%, while still collecting the same amount of revenue.

That’s a tax cut of almost 19% for families earning $127,000 or less. Families earning between $127,000 and $165,000 would also pay less tax, though the gain to them would be smaller. Only families earning about $165,000 would pay more.

This form of tax cut also encourages businesses to hire more low- and middle-income workers, and to pay them better. Currently, both employers and employees are subject to the payroll tax, and they each pay at the same rate — so for each employee, a company pays 7.65% on the first $127,000 of that employee’s salary, and 1.45% on any salary above that.

That structure encourages income inequality. Because the tax rate goes down as incomes go up, it is cheaper for a company to give raises to high-income executives than to low-income workers.

For example, a company that gives a $10,000 raise to a low-wage employee incurs an additional $765 in tax per year. If the company gives that same $10,000 raise to its CEO, it will pay only $145 in extra tax. Closing the payroll tax loophole would eliminate that perverse incentive. It would also reduce the cost of hiring new low-wage workers.

And by the way: Workers in the so-called “gig economy,” such as Uber drivers and Task Rabbit carpenters, have to pay both the employee part of the payroll tax and the employer part, so these vulnerable workers are hit twice.

One final piece of advice for congressional Democrats. Even though Trump initially claimed that his tax proposal would be revenue-neutral, the plan he just outlined would swell the deficit by more than half, according to the Tax Policy Center.

Many economists view such a big deficit as irresponsible. But let’s be realistic: Tax cuts are popular; the offsetting increases most certainly are not. In the coming debate, Democrats will need to fight fire with fire. If the administration does end up sending Congress a tax cut bill, then the Democratic alternative should be a tax cut as well — but one that helps struggling middle-income families, just like Trump promised.

Yassky is dean of the Elisabeth Haub School of Law at Pace University, and a former counsel to the House of Representatives Subcommittee on Crime.